QE and its relationship to Bitcoin

If you have spent any time down the rabbit hole of cryptocurrencies and Bitcoin over the last couple of years and had the pleasure of listening to a Bitcoin commentator with a macroeconomics bent, talk about how Bitcoin is impacting the wider economy you will have heard the term ‘QE”.  If like me, you last studied macroeconomics at college and your profession is far away from Wall Street then you will be asking yourself – what is QE? and more importantly why do I care?  Well ask no further this blog post is for you…

What Is QE? 

QE is Quantitative Easing and it is a somewhat unconventional monetary policy in which a central bank purchases government securities, bonds or other securities such as company stocks from the market in order to increase the money supply and encourage lending and investment. Sounds straightforward on the surface…

Let me put this more simply – the government is buying bonds or stocks with the taxpayers money.

Why is the government doing this?

When a situation arises where central bank set interest rates are at or approaching zero, the ability for a central bank to control the economy via interest rates alone is no longer effective, so instead a central bank can target specified amounts of bonds or shares to purchase. Quantitative easing increases the supply of money in circulation by purchasing assets with newly created bank reserves in order to provide banks with more liquidity.

The plot thickens – the government is printing money to buy stocks or bonds to keep the economy ticking. Hmmm… let that one sink in for a moment…

Understanding Quantitative Easing in more detail

To execute Quantitative Easing, central banks increase the supply of money by buying government bonds and other securities. Increasing the supply of money is similar to increasing the supply of any other asset – it lowers the cost of the asset, in this case, money. A lower cost of money means that the prevailing interest rates are subsequently lower and therefore banks can lend more easily. This strategy is used when interest rates approach zero or are close to zero (as has been the case since 2008).  The rationale being that interest rates have disappeared as a mechanism to control the economy, so central banks need another lever to pull to influence economic growth.

When I said let this concept sink in, the penny should now be dropping (excuse the pun). Quantitative Easing blurs the line between monetary and fiscal policy. Just imagine the scenario that the assets purchased consist of long-term government bonds that are being issued by the Government o finance counter-cyclical deficit spending.  Now, of course, this would never happen, the government buying its own bonds with freshly printed money supply…

The Drawbacks of Quantitative Easing

If central banks increase the money supply, it can lead to inflation. In the worst-case scenario, a central bank may cause inflation through QE without economic growth, causing a period of so-called stagflation (basically what has happened in Japan over the last decade).

Central banks are created by their respective countries’ governments and are involved in some regulatory oversight. However, central banks cannot force the banks that operate in their jurisdiction to increase lending or force borrowers to seek loans and invest. Challenges arise if the increased money supply does not work its way through the banks and trickle out into the wider economy, so QE may not be effective except as a tool to facilitate deficit spending.

Or put another way QE allows a government to spend money it hasn’t raised in taxes through buying of its own debt with freshly printed money…

It gets worse. Another potentially negative consequence is that quantitative easing can devalue the domestic currency. For manufacturers, this may help stimulate growth because exported goods would be cheaper in the global market. However, a falling currency value makes imports more expensive, which can increase the cost of production and consumer or retail price levels.

Put another way – QE allows a government to spend money it hasn’t raised in taxes through buying of its own debt with freshly printed money and this leads to the population’s money being worth less year on year.

Is Quantitative Easing Effective?

During the QE programs conducted by the US Federal Reserve starting in 2008, the Fed increased the money supply by $4 trillion. This means that the asset side of the Federal Reserve’s grew significantly as it purchased bonds, mortgages, and other assets. The Fed’s liabilities, primarily reserves at U.S. banks, grew by the same amount. The goal was that the banks would lend and invest those reserves to stimulate growth.

However, banks held onto much of that money as excess reserves. At its peak, U.S. banks held $2.7 trillion in excess reserves, which was an unexpected outcome for the Fed’s QE program.

What has this got to do with Bitcoin?

Great Question! Bitcoin will only ever have 21 million Bitcoins, not one more not one less.  This level of certainty in the supply side of a currency is powerful.  It means that Bitcoin is hard money.  Also due to the decentralized and community-driven nature of Bitcoin, no one government or entity controls Bitcoin meaning nobody can change the supply of Bitcoin to suit their whims.

As the Federal Reserve tries to manipulate the money supply, the supply of credit, inflation and economic growth the one thing that suffers is the value of the money that this the unit of measure for the economy.  Inflation, or put another way the debasement of money, erodes savings in the hope that consumption will happen in the short term to keep the economy humming.

Bitcoin turns this dynamic on its head.  With a store of value that favours a long time horizon over the alternative where short term consumption is encouraged, Bitcoin makes a compelling case when you take mass consumption and the environmental problems it creates into account.

Put simply – Hodl-ing Bitcoin is good for the environment!

 

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